OPINION:
A year ago, dairy farmers were riding high with a Fonterra payout of $8.40 a kilogram of milksolids. Now, the global dairy trade has slumped, auction prices have tumbled and it is highly likely Fonterra will have to cut further below its revised forecast payout of $6 a kilogram for this season.

The ground lost so far has already slashed $4 billion from dairy farmers' incomes nationwide and will reduce national gross domestic product by $2 billion. Things may get worse before they get better. The results of Fonterra's auction over Tuesday night also drove the New Zealand dollar lower yesterday.

Dairy prices have now fallen in 11 of the last 13 fortnightly Fonterra auctions. Tuesday night saw prices fall 8.4 per cent overall and the US dollar dairy price index has now slumped 41 per cent since early February.

When changes to the New Zealand dollar are factored in, the slide amounts to 43 per cent for the dairy industry here. Analysts and others watching the dairy sector say they are surprised at the latest hit in the continuing slide and all eyes will be on the next auction, on August 19.

For dairy farmers, this will be a nervous time. Their income will be reduced, obviously, and their budgets squeezed. Those who have borrowed heavily during the boom of the last couple of years, particularly to carry out dairy conversions or to expand their businesses to take advantage of it, will be especially anxious. Expect less discretionary spending in the rural centres which support dairying communities.

However, the downturn, although sharp, should not be a cause for panic. Dairy prices have been volatile over the last decade or so, and slumped in a similar fashion through the first half of 2012 before rising strongly again.

There are also good reasons why demand has fallen so significantly and they look to be relatively short-term.

Chief among these is that China, which was taking more than half of New Zealand's dairy exports before the downturn began, has amassed large stockpiles and is currently not in the market. That situation is likely to continue in the short term, and possibly through to the end of the year, but Chinese demand is not going to go away permanently.

Another issue is that, perversely, the last year has been a good production year for dairy farmers globally, so supply is on the high side. For example, Fonterra collected 1.58 billion kilograms of milksolids across New Zealand in the last season, which ended on May 31, and this was 8.3 per cent higher than the previous season.

In the longer view of dairy's future, the underlying imperatives that are expected to drive future growth and demand have not changed. These include population growth and the rising incomes in developing countries such as China and India, which are also becoming more urbanised and western-oriented in their diet.

The New Zealand-China free trade agreement puts us in a stronger position to take advantage of these trends in that country.

Chinese demand, and hence the dairy auction price, will rise again. This should be seen as a cyclical downturn and not a terminal one.